Sovereign Debt

by

Paul Lejot

• LAST REVIEWED: 27 September 2017
• LAST MODIFIED: 27 September 2017
• DOI: 10.1093/obo/9780199796953-0155

Introduction

This article discusses a concern of legal scholars that is surprisingly new, given that the roots of state borrowing easily predate the Common Era. Conflicts between state succession and prior indebtedness are noted by Aristotle; state fundraising in eleventh century Byzantium would be recognizably sophisticated for today’s contract drafters; while debts incurred by princes and emperors had become so pervasive and permanent in eighteenth century Europe as to exasperate Adam Smith, despite his favoring state spending on worthy public goods. Today’s academic interest results from two factors—first, sovereign debt becoming from the 1970s increasingly held or controlled by commercial parties of widening variety and diverging objectives, partly superseding states and supranational agencies as lenders; second, a migration to cross-border borrowing in foreign currencies rather than issuance at home that would typically be subject to more pliable domestic law. The focus here is accordingly with peculiarities of state debts arising from their being commercial rather than treaty obligations—in particular, conflicts of private law and issues caused by contractual incompleteness. All center on aspects of law or practice unique to sovereign borrowers, especially the absence of a single coordinating mechanism among creditors similar to national insolvency law. Sovereign debt is also associated with the laws of state succession and sovereign immunity, and the influence of Soft Law on transnational finance, topics considered elsewhere in Oxford Bibliographies Online in International Law (see “State Succession,” “Sovereign Immunity,” and “Soft Law”), while its singularity has more lately interested scholars of public law, who approach the subject with concerns for borrowing and lending practices judged against ethical considerations, the enforceability of foreign debts contracted by fallen regimes, and the sustainability of those accumulated by the poorest states. Sovereign debt means financial claims against the state in the narrow sense of an obligation entered on its behalf by central government. It may include financial claims created to settle trade commitments or disputes, but never obligations assumed by agencies or enterprises of the state such as central banks, although supranational, sub-sovereign, and agency (SSA) securities of high credit quality are often treated by modern capital market participants as a single class of debt and acceptable substitutes for sovereign issues, especially since sovereign debt is no longer seen as sweepingly “risk-free” as traditionally suggested by the finance literature.

Overview

Commercial issues of sovereign debt typically take an elemental form as bonds, loans, or promissory notes, some of which may be treated by statute or in commercial codes as securities or negotiable instruments, and are generally subject to similar customary and regulatory practices as transactions arranged for all public or supranational borrowers. They now refer most commonly to cross-border claims issued in the international capital markets, usually denominated in a currency not under the obligor’s sovereign control, a transition explained in Lejot, et al. 2006. Only rarely have modern commercial issues of sovereign debt been treated as subject to international investment agreements (see Treatment of Sovereign Claims), while inter-state financial claims—except those arising from commercial agreements—and those sovereign obligations held by supranational organizations such as the World Bank are treaty commitments subject to international law. Much of the discussion here deals with the technical and inter-related effects of national (or “municipal”) contract law and entrenched transnational customs, as described in Brummer 2010, since most transactions are governed either by English or New York law. These effects include legal lacunae, or gaps between the functioning of the governing laws of contracts, market custom, and international law to which states are otherwise subject, resulting from the uniqueness of sovereign issuers as commercial debtors that make agreements incapable of full enforcement, despite being subject to acknowledged forms of law. The results appear most frequently in cases of external payment distress by making consensual debt restructurings complex and subject to unexpected risks, explained from the borrower’s perspective in Frieda 2014. The prevalence of payment problems has helped falsify the notion that sovereign debt can ever be “risk-free,” as acknowledged in Bank for International Settlements 2013. As a non-traditional stream of law the subject lacks comprehensive contemporary texts other than collections intended for non-specialists, so that only Megliani 2015 is broad and deep in scope. Popular texts in “neighboring” fields such as Hudson’s Law of Finance or Scott and Gelpern’s International Finance give it limited treatment focused on debt restructuring, albeit a contemporary concern that distinguishes sovereign debt as a topic in contract law. Neither is the field fully addressed in the academic or practitioner-focused literatures, although issues of current attention are often expansively covered, occasionally in dedicated editions of scholarly journals. This has been noticeable during Greece’s debt renegotiations within the Eurozone after 2009 and in disputes over Argentina’s defaulted external debt since 2000 (see Litigation and Legal Shocks).

• Bank for International Settlements. Sovereign Risk: A world without risk-free assets?. BIS Papers No.72. Basel: Bank for International Settlements, 2013.

  Survey of legal, regulatory, and functional aspects of sovereign debt, drawing lessons from Eurozone experiences. “Risk-free” refers to the supposed credit quality of certain sovereign issues, and the finance literature’s presumption that state obligations denominated in the issuer’s sovereign currency are nominally risk-free, and thus provide legitimate pricing benchmarks.

• Brummer, Chris. “Why Soft Law Dominates International Finance—and not Trade.” Journal of International Economic Law 10.3 (2010): 623–643.

  DOI: 10.1093/jiel/jgq026

  Succinct explanation of the predominant modern treatment in law of transnational financial claims—including commercially contracted sovereign debt—represented by a convergence of accepted financial practices and the adoption by most participants of preferred forms of national law into a cross-border setting. Compare with Sack 1927, cited under State Immunity and Contractual Enforceability.

• Frieda, Gene. “Sovereign Debt Markets.” In Sovereign Debt Management. Edited by Rosa Maria Lastra and Lee Buchheit, 287–308. Oxford: Oxford University Press, 2014.

  Broad, compact introduction to the motives and freedom of action of state borrowers set against modern market practices, intended to give context to a substantial collection dealing with the modern treatment of distressed states, restructuring, legal anomalies, and proposals for reform.

• Lejot, Paul, Douglas Arner, and Frederik Pretorius. “Institutional Reform and Economic Development.” In Asia’s Debt Capital Markets: Prospects and Strategies for Development. Edited by Douglas Arner, Jae-Ha Park, Paul Lejot, and Qiao Liu, 119–142. New York: Springer, 2006.

  Explains the development of markets in debt securities from the early modern era to today’s international capital markets, and the utility for emerging states of enhancing institutional mechanisms for sovereign debt issuance. One of few academic narratives to examine the virtues of issuance in non-traditional markets.

• Megliani, Mauro. Sovereign Debt: Genesis, Restructuring, Litigation. Dordrecht: Springer, 2015.

  DOI: 10.1007/978-3-319-08464-0

  Thorough description of sovereign debt instruments and forms of claim held singly and in concert by commercial, state, and supranational agency investors, how their effectiveness differs among classes of creditors, and ways in which major forms of law assist or impede the normal or distressed operation of these markets.